TERMS RELATED TO BANKING NOTES

► Non-Performing Asset (NPA): A loan is categorized as NPA if it is due for a period of more
than 90 days. Depending upon the due period, the NPAs are categorized as under:

 Sub-Standard Assets: > 90 days and less than 1 year

 Doubtful Assets: greater than 1 year

 Lost Assets: loss has been identified by the bank or RBI, but the amount has not been written
off wholly.

o Stressed assets = NPAs + restructured loans + written off assets

o Restructured loans: those assets which got an extended repayment period, reduced interest
rate, converting a part of the loan into equity, providing additional financing, or some
combination of these measures.

o Written off assets: When the lender does not count that money, borrower owes to him, then
the asset is called written off assets. However, it does not mean that the borrower is pardoned
or exempted.

Note: In case of agricultural loans, the loan is classified as NPA if it satisfies the below criteria:

 Instalment of principal or interest remains overdue for two crop seasons for short duration
crops,

 Instalment of principal or interest remains overdue for one crop season for long duration
crops.

Note: Long duration crops are the crops with crop season longer than one year and short duration
crops are the crops with crop season shorter than one year.

► Special Mention Accounts (SMA): Introduced by the RBI in order to identify the incipient
stress in the assets of the banks and NBFCs. These are the accounts that have not-yet turned
NPAs (default on the loan for more than 90 days), but rather these accounts can potentially
become NPAs in future if no suitable action is action.

 SMA-0: Principal or interest payment not overdue for more than 30 days but account showing
signs of incipient stress

 SMA-1: Principal or interest payment overdue between 31-60 days

 SMA-2: Principal or interest payment overdue between 61-90 days

Note: If the Principal or interest payment is overdue for more than 90 days, then the loan is
categorized as NPA.

► Provisioning Coverage Ratio (PCR): Under the RBI's provisioning norms, the banks are
required to set aside certain percentage of their profits in order to cover risk arising from
NPAs. It is referred to as "Provisioning Coverage ratio" (PCR). It is defined in terms of
percentage of loan amount and depends upon the asset quality. As the asset quality
deteriorates, the PCR increases. The PCR for different categories of assets is as shown below:

1
 Standard Assets (No Default): 0.40%
NOTES
 Sub-standard Assets (> 90 days and less than 1 year): 15%

 Doubtful Assets (greater than 1 year): 25%-40%

 Loss Assets (Identified by Bank or RBI): 100%

► Gross and Net NPA: Gross NPA refers to the total NPAs of the banks. The Net NPA is
calculated as Gross NPA -Provisioning Amount.

► Capital Adequacy ratio (CAR): The CAR has been laid down by the BASEL committee on
banking supervision under Bank of International Settlement located in Basel, Switzerland. It
has been laid down to ensure financial stability and to prevent failure of banks. So far, 3 BASEL
Norms have been laid down: Basel I (1998), Basel II (2004), Basel III (2009).

CAR is the ratio of a bank's capital to its risk. It is also known as the Capital to Risk (Weighted)
Assets Ratio (CRAR)

CAR= (Tier-1 Capital + Tier-2 Capital)/ RWAs * 100.

The Banks in India are required to maintain CAR of 9% (Tier-1 capital: 7% + Tier-2 Capital: 2%)
along with Capital Conservation buffer (CCB) of 2.5%.

Hence, unlike the BASEL III norms, which stipulate capital adequacy of 10.5% (8%-CAR + 2.5%
CCB) , the RBI has mandated to maintain capital adequacy of 11.5% (9%-CAR + 2.5%-CCB)

► Liquidity Coverage Ratio (LCR): It is the minimum required high-quality liquid assets
(HQLA) that the banks must hold to allow them to survive a liquidity stress for 30 days. It was
introduced under Basel III to improve a bank’s short-term resilience to liquidity shocks.

HQLA are assets that can be converted into cash quickly with no significant loss of value. Thus
HQLAs include

 Cash outside the Cash Reserve Ratio requirement

 Gold

 G-sec outside SLR requirement

 Assets under SLR.

 High-rated corporate bonds

► Facility to avail Liquidity Coverage Ratio (FALLCR): Facility to Avail Liquidity for LCR. The RBI
has declared that the entire SLR-eligible assets held by the Banks can be considered as HQLAs
for meeting LCR requirements.

► Leverage Ratio (LR): The Basel Committee on Banking Supervision (BCBS) introduced
Leverage ratio (LR) in the 2010 Basel III package of reforms. The Formula for the Leverage
Ratio is (Tier 1 Capital/ Total Consolidated Assets) ×100 where Tier 1 capital represents a
bank's equity.

2
It is to be noted that the Tier 1 capital adequacy ratio (CAR) is the ratio of a bank’s core tier 1
capital to its total risk-weighted assets. On the other hand, leverage ratio is a measure of the NOTES
bank's core capital to its total assets.

Thus, the Leverage ratio uses tier 1 capital to judge how leveraged a bank is in relation to its
consolidated assets whereas the tier 1 capital adequacy ratio measures the bank's core capital
against its risk-weighted assets.

► Banking Stability Index (BSI)

 It is a measure of the level of interdependence of financial institutions mainly banks. It is “the

expected number of banks that could become distressed given that at least one bank has
become distressed”.

 If more banks are expected to become distressed if one bank in the system is distressed, then
the BSI is higher

 Parameters: Efficiency of the Banks, Profitability, Soundness, Liquidity, Asset Quality.

► DOMESTIC-SYSTEMICALLY IMPORTANT BANKS (D-SIBS)

Systemically Important Banks (SIBs): The SIBs are perceived as banks that are ‘Too Big to Fail
(TBTF)’. There is a need for stronger regulatory environment for the SIBs. In this regard, the Basel
Committee on Banking Supervision (BCBS) came out with a framework in 2011 for identifying the
Global Systemically Important Banks (G-SIBs). Similarly, the RBI has been mandated to identify the
Domestic systemically Important banks (D-SIBs) and lay down suitable regulatory requirements to
prevent their failure.

How are Domestic- Systemically Important Banks (D-SIBs) identified?

Qualifying Criteria: To identify the D-SIBs, the RBI considers only those banks whose size is equal
to or more than 2% of GDP.

Criteria used for Identification of D-SIBs:

 Size: Failure of Bank with higher Balance sheet can cause greater damage to Economy.

 Interconnectedness: Extent of linkages with other Banks and financial institutions. Failure of
Bank with higher interconnectedness can cause greater damage to Economy.

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 Substitutability: Lack of readily available substitutes. Failure of a large bank would inflict
greater damage if certain critical services provided by the bank cannot be easily substituted by NOTES
other banks.

 Complexity: The more complex a bank is, the greater are the costs and time needed to
resolve its problems.

Computation of Score: The systemic importance of a bank is computed as weighted average

scores of all 4 indicators. Thus, the systemic importance score of a bank would represent its
relative importance with respect to the other banks. Banks that have scores above a threshold
score are classified as D-SIBs.

Note: Presently, the SBI, ICICI Bank, and HDFC Bank have been identified as Domestic Systemically
Important Banks (D-SIBs).

Higher Capital Requirement for D-SIBs

The D-SIBs are placed under different buckets (categories) depending upon their importance.
According to the bucket in which they are placed, the bank would be required to maintain higher
Tier-I capital under the BASEL Norms as shown below:

► EASE Reforms Index: Enhance Access & Service Excellence (EASE) reforms index. It measures
the performance of Public Sector Banks on 140 objective metrics across 6 themes. It is
published by Indian Banks’ Association.

► LIBOR: The RBI has issued an advisory to Banks to cease entering into new financial contracts
that reference LIBOR as a benchmark and instead use any widely accepted alternative
reference rate (ARR).

Details: London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which the global
banks lend to each other. LIBOR is also linked to interest rates at which Indian corporate sector
borrows money under external commercial borrowings. The rate is calculated and published each
day by the Intercontinental exchange (ICX).

In the aftermath of LIBOR scandal of 2011, some countries have decided to adopt alternatives to
LIBOR by the end of 2021.

Some of the alternatives to LIBOR are:

 UK: Sterling Overnight Index Average (SONIA)

 USA: Secured Overnight Financing Rate (SOFR)

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 Switzerland: Swiss Average Rate Overnight (SARON)
NOTES
 Japan: Tokyo Overnight Average Rate (TONAR)

 European Union: Euro Short-Term Rate (ESTER)

Note: Mumbai Interbank Offered Rate (MIBOR) is India’s domestic reference rate for inter-bank
lending. The MIBOR is calculated every day by National Stock Exchange of India (NSEIL).

► SWIFT: The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a secure
financial message carrier that transports messages from one bank to its intended bank
recipient to facilitate cross-border payments. It does not facilitate funds transfer: rather, it
sends only payment orders.

Details about SWIFT:

 Global member-owned cooperative that is headquartered in Brussels, Belgium. Founded in

1973.

 Presently, it has more than 11,000 Banks and financial institutions which are spread across
200 countries. Prior to SWIFT, the only reliable means of message confirmation for
international funds transfer was Telex. It was discontinued due to a range of issues such as
low speed, security concerns etc.

 SWIFT hosts an annual conference known as Sibos (Swift International Banking Operations
Seminar) in various cities across the world.

How does the SWIFT Work?

SWIFT Code or Bank Identifier Code: Every Bank has a SWIFT Code consisting of 8 or 11
characters. An 11-digit code refers to a specific branch, while an 8-digit code (or one ending in
'XXX') refers to the bank's head office. It is also referred to Bank Identifier Code (BIC). It is similar to
the IFSC code used for domestic interbank transfers, with Swift being used for international
transfers.

NOSTRO and Vostro Account:

5
Transfer of Messages through SWIFT:
NOTES

Alternatives to SWIFT:

 Russia developed its own alternative to SWIFT called as System for Transfer of Financial
Messages (SPFS). But this system has struggled to establish itself in international transactions.

 Similarly, China has launched the Cross-Border Interbank Payment System in 2015 to
internationalise the use of the yuan. It allows global banks to clear cross-border yuan
transactions directly onshore.

► AT-1 Bonds

Understanding BASEL-III Guidelines: According to the RBI’s guidelines, the regulatory capital to
be maintained by the Indian banks under BASEL III is as under:

 Tier-1 Capital: 7% (Core Equity capital consisting of Minimum Common Equity Tier 1 of 5.5%
and Additional Tier 1 capital of 1.5%)

 Tier-2 Capital: 2% (Basically comprising of Debt)

 Capital Conservation Buffer: 2.5%

 Total Regulatory Capital: 11.5% of Risk-weighted Assets

What are Additional Tier-1 Bonds?

The AT-1 Bonds are the unsecured and perpetual bonds which are issued by the Banks to meet
regulatory capital requirements of 1.5% of Additional Tier 1 Capital under the BASEL III norms.
However, they are quite different from the normal bonds in a number of ways:

Hybrid Instruments: The AT-1 Bonds are considered to be hybrid of shares and bonds. Just like
shares, there is no obligation to return the money or pay the dividend. Just like bonds, the bank
pay interest on such AT-1 bonds.

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Perpetual Bonds: These Bonds do not have maturity period. Instead, these bonds carry call
options i.e. the banks have an option redeem them after five or 10 years. But banks are not NOTES
obliged to use this call option and they can opt to pay only interest on these bonds for
perpetuity. That is why they are called as Perpetual Bonds.

No Put Option: Investors do not have put option i.e. the investors cannot return back the AT-1
bonds to the banks. However, the investors can sell these bonds in the secondary market.

Skip Interest Payments: The Banks issuing the AT-1 bonds can skip payment of interest for a
particular year. They can also reduce the face value of the bond. However, the banks can do so
only when their regulatory capital ratio falls below certain threshold levels. These threshold levels
are clearly specified when Banks issue AT-1 bonds.

Writing down of AT-1 Bonds: If the RBI feels that any bank is under a financial crunch, it can
waive off the liability of the banks to redeem the AT-1 bonds and completely write it off. The RBI
has used this option in the case of Yes Bank.

► Prompt Corrective Action (PCA): Recently, the RBI has come out with the revised Prompt
Corrective Action (PCA) framework. The provisions of the revised PCA Framework will be
effective from January 1, 2022.

► Haircuts: It refers to the difference between the loan amount and actual amount recovered by
the Bank from their defaulting customer. Various steel, power, infrastructure, aviation
companies etc have defaulted on their loan repayment leading to increase in the NPAs of
banking Sector.

Under such circumstances, the Banks usually arrive at a compromise formula where the
borrower offers to pay part of loan amount as a one-time settlement. The ‘haircut’ here is the
loss made by Bank since the amount paid by the defaulting customer is lower than the actual
loan amount.

► Inverted Yield Curve: A yield curve is a graph that depicts yields on bonds ranging from short-
term debt such as one month to longer-term debt such as 30 years.

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Types of Yield Curve and their interpretation
NOTES
The yield on the bonds depends upon the risk involved. Higher the risks, higher would be the
yields.

Normal Yield Curve

Normally, the yield on short term maturity bonds is lower than that of long-term maturity bonds.
This can be attributed to increased risk in the longer term (say 30 years). A normal yield curve
indicates yields on longer-term bonds may continue to rise, responding to periods of economic
expansion.

Inverted Yield Curve

When there are signs of slowdown in an economy, it would mean that the economy faces risk in
the short term. However, in the long term, the economy may come back to normalcy. Hence, due
to this, the yield on the short-term bonds becomes higher than the yields of long-term bonds.
(Inverted Yield Curve). Hence, an inverted yield curve points towards a probable economic
recession.

► Wilful Defaulter

The RBI defines a Wilful Defaulter as

 The unit which has defaulted even when it has the capacity to repay.

 The unit which has defaulted and has not utilised the loans for the specific purposes for which
finance was availed of but has diverted the funds for other purposes.

 The unit which has defaulted and has siphoned off the funds so that the funds have not been
utilised for the specific purpose for which finance was availed and the funds are not available
with the unit in the form of other assets.

 The unit which has defaulted and has also sold off the collateral used for availing loans

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► Fugitive Economic Offender
NOTES
Definition of Fugitive Economic Offender: A person against whom an arrest warrant has
been issued for committing an offence listed in the Act and the value of the offence is at least
Rs. 100 crores. Such a person may have either left India to avoid criminal prosecution; or being
abroad, refuses to return to India to face criminal prosecution.

List of Offences: Some of the Offences listed in the act are counterfeiting government stamps
or currency, Cheque dishonour, Money laundering, Transactions defrauding creditors, Evasion
of taxes, Corruption by Civil Servants etc.

Procedure to Declare Fugitive Economic Offender: Director or Deputy Director appointed

under Prevention of Money Laundering Act (PMLA) Act, 2002--->Files Application before the
Special Court constituted under PMLA Act---> if the person fails to appear before the special
court within six weeks of issuance of notice---> Declared as Fugitive Economic Offender. ( If the
person appears before the court within 6 weeks, the proceedings to declare him as FEO get
terminated).

Power to confiscate properties: Confiscate properties which: (i) are proceeds of crime, (ii) are
benami properties in India or abroad, and (iii) any other property in India or abroad. Upon
confiscation, all rights and titles of the property will vest in the central government

► Regulatory Forbearance: The term Regulatory Forbearance means giving certain exemptions
from complying with the regulatory requirements. In case of Banking sector, the RBI provides
certain leeway to the Banks to comply with its regulations. It is normally provided to enable
the Banks to tide over the tough economic conditions such as Global Financial Crisis (GFC)
2007-08.

For example, post GFC in 2007-08, the RBI enabled the Banks to undertake the debt
restructuring of Stressed assets. These assets continued to be categorised as Standard Assets.
This in turn reduced the provisioning requirements of the Banks, enabled the Banks to provide
enhanced credit to kickstart the Indian Economy.

► Interest Coverage Ratio (ICR) and Zombie Firms: The interest coverage ratio is used to
measure how well a firm can pay the interest due on outstanding debt. The interest coverage
ratio is calculated as ratio of a firm’s profit after tax to its total Interest expenses. Firms with
Interest Coverage ratio (ICR) lower than 1 would be unable to meet their interest obligations
from their income and hence called as “Zombie Firms”.

► SARFAESI ACT: The SARFAESI Act essentially empowers banks to directly auction residential or
commercial properties that have been pledged with them to recover loans from borrowers. As
per the SARFAESI Act, if a borrower defaults on a loan, the Banks can give a notice period of 60
days to the borrower to repay the loans. If the borrower fails to repay within 60 days, the
Banks can take the following actions:

1. Take possession of the pledged assets and then lease or sell it off to recover the loan
amount.

2. Take over the management of the business of the borrower.

3. Appoint a person to manage the assets.

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 NOTES

Difference between SARFAESI Act and IBC, 2016

1. SARFAESI- Applicable only for secured financial creditors; IBC- Applicable for both secured and
unsecured financial creditors.

2. Unlike IBC, SARFAESI is not applicable to Operational Creditors.

3. The minimum threshold for invoking IBC: Individuals (Rs 1000); Companies (Rs 1 crore);
Minimum threshold for SARFAESI: Rs 1 lakh.

► Insolvency and Bankruptcy Code:

Rationale: The IBC Code was introduced to consolidate all the existing laws related to Insolvency
and Bankruptcy in India and to simplify the process of insolvency resolution. Deals with all aspects
of insolvency and bankruptcy of all kinds of companies, LLPs, Partnerships and Individuals;
however it does not deal with insolvency of banks.

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INSTITUTIONAL MECHANISM
NOTES
Insolvency Professionals to administer the resolution process, manage the assets of the debtor,
and provide information for creditors to assist them in decision making.

Insolvency Professional Agencies to conduct examinations to certify the insolvency

professionals.

Information Utilities to report financial information of the debt owed to them by the debtor.

Adjudicating authorities: National Companies Law Tribunal (NCLT) for companies; and the Debt
Recovery Tribunal (DRT) for individuals.

Committee of Creditors (CoC) may either decide to restructure the debtor’s debt by preparing a
resolution plan or liquidate the debtor’s assets. However, such a decision has to be approved by at
least 66% of the votes. (Earlier threshold- 75%).

Insolvency and Bankruptcy Board to regulate insolvency professionals, insolvency professional

agencies and information utilities set up under the Code.

PROCEDURE
Insolvency Resolution Process (IRP): When a default occurs, the resolution process may be
initiated either by the debtor or creditor before the adjudicating authority. The NCLT appoints an
insolvency professional to administer the IRP. The Resolution Professional identifies the financial
creditors and constitutes a Committee of Creditors (CoC). The CoC would prepare the resolution
plan for the restructuring the loans of the defaulted borrower. However, such a resolution plan
has to be approved by at least 66% of the votes in the committee of creditors.

Liquidation (Sale of Assets) would take place if the Committee of Creditors fail to come up with a
resolution plan within the time limit of 330 days.

Recent Announcement: The Government has decided to increase the threshold for invoking IBC
for the Corporates from Rs 1 lakh to Rs 1 crores. ( For individuals, the threshold is Rs 1000).

► Pre-Pack Insolvency: Under PIRP, there is a direct agreement between the debtor
(Borrower) and Creditor (Lender) to restructure the loans. There is no public bidding of the
resolution plans and hence no role for the external parties. Resolution takes place through
informal and direct agreement between the debtor and creditor. This ensures that the
company remains in the control of promoters. This is particularly helpful for those companies
which may have defaulted due to adverse economic conditions. So, PIRP offers a unique
mechanism of Informal out of court settlement accompanied by legal recognition of such
settlements under IBC.

11
Difference between CIRP and PIRP:
NOTES

► Recapitalisation of PSBs: Refers to injection of capital mainly through equity investment by

the government to financially strengthen the PSBs.

Government’s Plan: Infuse capital through Recap Bonds + Budget Support + Equity Capital
from Market.

Rationale: Improve Balance Sheets + Meet Capital requirements under PCA + promote GDP
growth.

Recap Bonds: The government issues recapitalisation bonds which would then be bought by
the banks. This money raised by the government is then used to buy the shares of the public
sector banks leading to increase in Bank’s Capital. The money raised by the Government
through the issuance of Recap Bonds is not accounted for calculation of Fiscal Deficit.
However, it is considered for the calculation of Internal Debt of Government.

Trends in Recapitalisation: Over Rs 2.5 lakh crores has been infused into Public Sector Banks
(PSBs) through recapitalization bonds over the past three years - Rs 80,000 crores in 2017-18,
Rs 1 lakh crores in 2018-19 and Rs 65,000 crore in 2019-20.

Recent Developments: The Government has issued Zero Coupon Recap Bonds for the first
time in 2020. The Zero-Coupon Recapitalization Bonds will have non-SLR status and will be
non-tradable.

► Lazy Banking: To get out of the present economic recession, there is a need to enhance credit
creation by the Banks. However, "Lazy Banking" by the Banks in India can derail the economic
revival.

Details: The depositor’s money mobilised by the Banks can be used either to invest in G-Secs
or provide loans to different sectors. Presently, the Banks are reluctant to give loans due to the
fear of increase in NPAs. Hence, on account of this, the Banks are investing more money in the
risk-free G-Secs. This is referred to as 'Lazy Banking".

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 PREVIOUS YEAR QUESTIONS
NOTES
Q1. What is the importance of the term Q3. What was the purpose of the Inter-
“Interest Coverage Ratio” of a firm in Creditor Agreement signed by Indian
India? banks and financial institutions
(Prelims 2020) recently? (Prelims 2019)

1. It helps in understanding the present (a) To lessen the Government of India’s

risk of a firm that a bank is going to perennial burden of fiscal deficit and
give a loan to. current account deficit

2. It helps in evaluating the emerging risk
of a firm that a bank is going to give a
loan to.
3. The higher a borrowing firm’s level of
Interest Coverage Ratio, the worse is
its ability to service its debt.
Select the correct answer using the code
given below:
(b) To support the infrastructure projects
of Central and State Governments
(c) To act as independent regulator in
case of applications for loans of Rs 50
crore or more
(d) To aim at faster resolution of stressed
assets of Rs 50 crore or more which
are under consortium lending.

(a) 1 and 2 only Answer: d

(b) 2 only

(c) 1 and 3 only Q4. Consider the following statements:

(Prelims 2018)
(d) 1, 2 and 3
1. Capital Adequacy Ratio (CAR) is the
Answer: a
amount that banks have to maintain in
the form of their own funds to offset
Q2. In the context of the Indian economy, any loss that banks incur if any
non-financial debt includes which of account-holders fail to repay dues.
the following? (Prelims 2020) 2. CAR is decided by each individual bank.
1. Housing loans owed by households Which of the statements given above is/are
2. Amounts outstanding on credit cards correct?

3. Treasury bills (a) 1 only

Select the correct answer using the code (b) 2 only

given below: (c) Both 1 and 2
(a) 1 only (d) Neither 1 nor 2
(b) 1 and 2 only Answer: a
(c) 3 only

(d) 1, 2 and 3

Answer: d

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